Facts of the Case

Sierra Industrial Enterprises Pvt. Ltd. entered into a licensing agreement with Nike International Limited for sourcing, marketing, and selling Nike-branded footwear and apparel in India.

Under the agreement:

  • The assessee was granted a non-transferable licence to use the Nike trademark.
  • Nike provided technical information and know-how relating to the manufacture and sale of products.
  • Royalty was payable at the rate of 5% of domestic sales.
  • Ownership of the trademark, registrations, applications, and goodwill remained exclusively with Nike.
  • Upon termination of the agreement, the assessee was required to return all confidential information, drawings, designs, and materials bearing the Nike trademark.
  • The assessee had no right to continue using the trademark or technical information after termination of the agreement.

The Assessing Officer disallowed royalty expenditure amounting to ₹90,62,600 on the ground that it represented capital expenditure.

The CIT(A) deleted the addition, and the ITAT affirmed the decision, holding that the royalty expenditure was revenue in nature.

 

Issues Involved

  1. Whether royalty paid by the assessee to Nike International Limited for the use of trademark and technical information constituted capital expenditure or revenue expenditure.
  2. Whether the assessee acquired any enduring benefit or capital asset through the licensing arrangement.

 

Petitioner’s Arguments (Revenue)

The Revenue contended that:

  • The Income Tax Appellate Tribunal erred in deleting the disallowance of ₹90,62,600 made by the Assessing Officer.
  • The royalty payment resulted in an advantage to the assessee and therefore should be treated as capital expenditure.
  • The expenditure was not merely recurring business expenditure but related to valuable rights obtained from Nike.

 

Respondent’s Arguments (Assessee)

The assessee maintained that:

  • The royalty payment was directly linked to annual sales and constituted a recurring business expense.
  • The licence granted only a limited and non-transferable right to use the Nike trademark and technical information.
  • Ownership of all intellectual property remained with Nike.
  • No permanent or enduring asset came into existence in favour of the assessee.
  • Upon termination of the agreement, all rights to use the trademark and technical information automatically ceased.

Therefore, the royalty payment was revenue expenditure allowable as a business deduction.

 

Court Findings

The Delhi High Court observed that:

  • Both the CIT(A) and the ITAT had carefully examined the terms of the licensing agreement.
  • The assessee was granted only a limited right to use the trademark and technical information during the subsistence of the agreement.
  • The royalty was computed with reference to sales made during a particular year.
  • The assessee did not acquire ownership rights over the trademark, technical know-how, or any intellectual property.
  • Upon termination of the agreement, the assessee lost all rights to use the trademark and technical information.
  • No asset or advantage of an enduring nature accrued to the assessee.

The Court reiterated the settled principle that expenditure can be treated as capital expenditure only when it results in the acquisition of a capital asset or provides an enduring benefit.

 

Court Order

The Delhi High Court held that the royalty paid by Sierra Industrial Enterprises Pvt. Ltd. was revenue expenditure and not capital expenditure.

Accordingly:

  • The order of the CIT(A) and ITAT was upheld.
  • The Revenue's appeal was dismissed.
  • No order as to costs was passed.

 

Important Clarification

The judgment clarifies that royalty payments made under a licence agreement for the use of trademarks and technical information will ordinarily be treated as revenue expenditure where:

  • Ownership of intellectual property remains with the licensor.
  • The licensee obtains only a limited right to use the intellectual property.
  • Royalty is linked to sales or business operations.
  • The licensee loses all rights upon termination of the agreement.
  • No enduring asset or permanent advantage is acquired.

The mere use of technical know-how or trademarks does not automatically convert royalty payments into capital expenditure if the licensee does not acquire proprietary rights in such assets.

Sections Involved

  • Section 260A, Income Tax Act, 1961 – Appeal before High Court.
  • Section 37(1), Income Tax Act, 1961 – Deduction of business expenditure.
  • Principles governing distinction between Capital Expenditure and Revenue Expenditure.

Link to download the order -

https://delhihighcourt.nic.in/app/case_number_pdf/2010:DHC:3440-DB/MMH14072010ITA8442010.pdf

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